Smithfield Foods, Inc., together with its subsidiaries (the “Company,” “we,” “us” or “our”) began as a pork processing operation called The Smithfield Packing Company, founded in 1936 by Joseph W. Luter and his son, Joseph W. Luter, Jr. Through a series of acquisitions starting in 1981, we have become the largest pork processor and hog producer in the world.
We produce and market a wide variety of fresh meat and packaged meats products both domestically and internationally. We operate in a cyclical industry and our results are significantly affected by fluctuations in commodity prices for livestock (primarily hogs) and grains. Additionally, some of the key factors influencing our business are customer preferences and demand for our products; our ability to maintain and grow relationships with customers; the introduction of new and innovative products to the marketplace; accessibility to international markets for our products including the effects of any trade barriers; and operating efficiencies of our facilities.
We conduct our operations through five reporting segments: Pork, International, Hog Production, Other and Corporate, each of which is comprised of a number of subsidiaries, joint ventures and other investments. The Pork segment consists mainly of our three wholly-owned U.S. fresh pork and packaged meats subsidiaries. The International segment is comprised mainly of our meat processing and distribution operations in Poland, Romania and the United Kingdom, as well as our interests in meat processing operations, mainly in Western Europe, Mexico and China. The Hog Production segment consists of our hog production operations located in the U.S., Poland and Romania as well as our interests in hog production operations in Mexico. The Other segment is comprised of our turkey production operations, our interest in Butterball, LLC (Butterball), our live cattle operations and our interest in live cattle joint venture operations. The Corporate segment provides management and administrative services to support our other segments.
Over the past few decades, we have completed numerous acquisitions. Recently, our overall focus has shifted from acquisitions to integration, driving operating efficiencies and growing our packaged meats business to fully leverage the benefits of our prior acquisitions. Additionally, we are currently focused on reducing and restructuring our debt and eliminating non-core or under-performing businesses.
Fiscal 2009 Business Developments
The following business developments have occurred since the beginning of fiscal 2009:
Pork Segment Restructuring
In February 2009 (fiscal 2009), we announced a plan to consolidate and streamline the corporate structure and manufacturing operations of our Pork segment (the Restructuring Plan). This restructuring is intended to make us more competitive by improving operating efficiencies and increasing plant utilization. The Restructuring Plan includes the following primary initiatives:
The closing of the following six plants (the production at each of these plants will be transferred to more efficient facilities):
The Smithfield Packing Company, Incorporated’s (Smithfield Packing) Smithfield South plant in Smithfield, Virginia;
Smithfield Packing’s Plant City, Florida plant;
Smithfield Packing’s Elon, North Carolina plant;
John Morrell & Co’s (John Morrell) Great Bend, Kansas plant;
Farmland Foods, Inc.’s (Farmland Foods) New Riegel, Ohio plant; and
Armour-Eckrich Meats, LLC’s (Armour-Eckrich) Hastings, Nebraska plant;
A reduction in the number of operating companies in the Pork segment from seven to three;
The merger of the fresh pork sales forces of the John Morrell and Farmland Foods business units; and
The consolidation of the international sales organizations of our U.S. operating companies into one group that is responsible for exports.
The new structure will allow us to focus on maximizing operating, marketing, financial and logistical synergies that will enable us to better meet the needs of our retail, foodservice and international customers who do business with multiple Smithfield Foods companies. We expect to achieve a net reduction of approximately 1,800 jobs in the Pork segment as a result of the restructuring. We expect the initiatives will be substantially completed by the end of the third quarter of fiscal 2010 and will result in annual cost savings and improved pre-tax earnings, after applicable pre-tax restructuring and impairment charges, of approximately $55.0 million in fiscal 2010 and $125.0 million by fiscal 2011.
As a result of the Restructuring Plan, we recorded pre-tax restructuring and impairment charges totaling $88.2 million in fiscal 2009. We anticipate recording additional charges totaling approximately $23 million through the first half of fiscal 2010 primarily related to plant consolidation, asset disposal and plant wind-down costs. In addition, we estimate that $52.0 million in capital expenditures will be required relative to plant consolidations in fiscal 2010.
Smithfield Beef Disposition
In October 2008 (fiscal 2009), we completed the sale of Smithfield Beef, Inc. (Smithfield Beef), our beef processing and cattle feeding operation that encompassed our entire Beef segment, to a wholly-owned subsidiary of JBS S.A., a company organized and existing under the laws of Brazil (JBS), for $575.5 million in cash.
The sale included 100% of Five Rivers Ranch Cattle Feeding LLC (Five Rivers), which previously was a 50/50 joint venture with Continental Grain Company (CGC, formerly ContiGroup Companies, Inc.). Immediately preceding the closing of the JBS transaction, we acquired CGC’s 50 percent investment in Five Rivers for 2,166,667 shares of our common stock valued at $27.87 per share and $8.7 million for working capital adjustments.
The JBS transaction excluded substantially all live cattle inventories held by Smithfield Beef and Five Rivers as of the closing date, together with associated debt. All live cattle inventories previously held by Five Rivers were sold by the end of fiscal 2009. Our remaining live cattle inventories (approximately 43,000 head) are currently being raised by JBS for a negotiated fee and sold at maturity at market-based prices. We expect all of the remaining live cattle inventories will be sold by the end of the first quarter of fiscal 2010.
The net proceeds from the JBS transaction were used to pay down our U.S. revolving credit agreement (the U.S. Credit Facility) and other long-term debt. As of May 3, 2009, we had received approximately $87 million in net proceeds from the sale of the retained live cattle inventories, which we also used primarily for debt reduction. Based on market prices as of May 3, 2009, we expect to receive an estimated $30 million of additional net proceeds from the remaining live cattle inventories, which we also plan to use primarily for debt reduction.
We recorded a pre-tax gain of approximately $99.7 million ($54.3 million net of tax) on the sale of Smithfield Beef in fiscal 2009. The results of Smithfield Beef are reported as discontinued operations, including the gain on the sale.
Groupe Smithfield—Campofrío Transaction
In June 2008 (fiscal 2009), we announced an agreement to sell Groupe Smithfield S.L. (Groupe Smithfield) to Campofrío Alimentación, S.A. (Campofrío) in exchange for shares of Campofrío common stock. In December 2008 (fiscal 2009), the merger of Campofrío and Groupe Smithfield was finalized. The new company, known as Campofrío Food Group, S.A. (CFG), is listed on the Madrid and Barcelona stock exchanges. The merger created the largest pan-European company in the packaged meats sector and one of the five largest worldwide.
Immediately prior to the merger, we owned 25% of Campofrío and 50% of Groupe Smithfield. We currently own 37% of the combined company.
The sale of Groupe Smithfield resulted in a pre-tax gain of $56.0 million, which was recognized in the third quarter of fiscal 2009.
Reduction of U.S. Sow Herd
Beginning in the third quarter of fiscal 2008 through the third quarter of fiscal 2009, we reduced the size of our U.S. sow herd by 10% in order to reduce the over supply of hogs in the U.S. market. This has resulted in a reduction of 100,000 sows, which will result in approximately 1.4 million fewer market hogs in fiscal 2010 and approximately 1.8 million fewer market hogs annually thereafter.
In addition, in June 2009 (fiscal 2010), we announced that we will further reduce our sow herd by 3%, or approximately 30,000 sows. We believe that this reduction will result in approximately 540,000 fewer market hogs annually.
In March and early April 2009 (fiscal 2009), a previously unknown strain of influenza A(H1N1) virus emerged in Mexico and the United States and spread rapidly around the world while receiving substantial publicity. Although the A(H1N1) virus is a combination of human, bird and swine influenza strains which is spreading through human-to-human transmission, media reports have generally referred to it as the “swine flu.” We believe that the A(H1N1) virus had only a short-term effect on U.S. pork demand, primarily in May 2009 (fiscal 2010). As American consumers received more accurate information about the virus, domestic pork demand has returned to more normal levels. We continue to experience restrictions on U.S. pork exports in some international markets, particularly China, which is negatively impacting our sales to that country in the first quarter of fiscal 2010.
DESCRIPTION OF SEGMENTS
The Pork segment consists mainly of three wholly-owned U.S. fresh pork and packaged meats subsidiaries. The Pork segment produces a wide variety of fresh pork and packaged meats products in the U.S. and markets them nationwide and to numerous foreign markets, including China, Japan, Mexico, Russia and Canada. The Pork segment currently operates over 40 processing plants. We process hogs at nine plants (six in the Midwest and three in the Southeast), with an aggregate slaughter capacity of approximately 118,000 hogs per day.
The Pork segment sold approximately 4.5 billion pounds of fresh pork in fiscal 2009. A substantial portion of our fresh pork is sold to retail customers as unprocessed, trimmed cuts such as butts, loins (including roasts and chops), picnics and ribs.
The Pork segment also sold approximately 3.1 billion pounds of packaged meats products in fiscal 2009. We produce a wide variety of packaged meats, including smoked and boiled hams, bacon, sausage, hot dogs (pork, beef and chicken), deli and luncheon meats, specialty products such as pepperoni, dry meat products, and ready-to-eat, prepared foods such as pre-cooked entrees and pre-cooked bacon and sausage. We market our domestic packaged meats products under labels that include Smithfield, Farmland, John Morrell, Gwaltney, Great, Cumberland Gap, Armour, Eckrich, Margherita, LunchMakers, Dinner Bell, Carando, Kretschmar, Lean Generation, Lykes, Cook’s, Esskay, Valleydale, Ember Farms, Rath, Roegelein, Ohse, Stefano’s, Williamsburg, Tom & Ted’s and Jamestown. We also sell a substantial quantity of packaged meats as private-label products.
Our product lines include leaner fresh pork products as well as lower-fat and lower-salt packaged meats. We also market a line of lower-fat value-priced luncheon meats, smoked sausage and hot dogs, as well as fat-free deli hams and 40% lower-fat bacon.
During the preceding three fiscal years, our main acquisitions in the Pork segment were:
Initial Investment Date
Premium Standard Farms, Inc. (PSF) Vertically integrated hog producer and pork processor. Producer of mostly fresh pork products.
Armour-Eckrich Producer of mostly branded packaged meats products with large market share in hot dogs, dinner sausages and luncheon meats based in Naperville, Illinois.
We continue to emphasize a strategy of converting an increasing percentage of our fresh meat raw materials into value-added, further processed meats. With the acquisition of Armour-Eckrich in fiscal 2007 and the addition of new bacon lines, we added enough capacity to be a net buyer of both hams and bellies. In July 2006 (fiscal 2007), we completed and opened a 240,000 square foot state-of-the-art cooked ham manufacturing facility in Kinston, North Carolina.
Includes by-products and rendering.
In fiscal 2009, export sales comprised approximately 16% of the Pork segment’s volumes and approximately 13% of the segment’s revenues.
Sources and availability of raw materials
Live hogs are the primary raw materials of the Pork segment. Historically, hog prices have been subject to substantial fluctuations. Hog supplies, and consequently prices, are affected by factors such as corn and soybean meal prices, weather and farmers’ access to capital. Hog prices tend to rise seasonally as hog supplies decrease during the hot summer months and tend to decline as supplies increase during the fall. This tendency is due to lower farrowing performance during the winter months and slower animal growth rates during the hot summer months.
The Pork segment purchased 45% of its U.S. live hog requirements from the Hog Production segment in fiscal 2009. In addition, we have established multi-year agreements with Maxwell Foods, Inc. and Prestage
Farms, Inc., which provide us with a stable supply of high-quality hogs at market-indexed prices. These producers supplied approximately 10% of hogs processed by the Pork segment in fiscal 2009. We also purchase hogs on a daily basis at our Southeastern and Midwestern processing plants, our company-owned buying stations in three Southeastern and five Midwestern states and, through April 2009 (fiscal 2009), from Canadian sources. Beginning in April 2009 (fiscal 2009), the Pork segment began procuring and processing only U.S. born and raised hogs.
We also purchase fresh pork from other meat processors to supplement our processing requirements. Additional purchases include raw beef, poultry and other meat products that are added to sausages, hot dogs and luncheon meats. Those meat products and other materials and supplies, including seasonings, smoking and curing agents, sausage casings and packaging materials, are readily available from numerous sources at competitive prices.
The International segment includes our international meat processing operations that produce a wide variety of fresh pork, beef, poultry and packaged meats products, including cooked hams, sausages, hot dogs, bacon, and canned meats. We have controlling interests in international meat processing and distribution operations located mainly in Poland, Romania and the United Kingdom. In addition, we have noncontrolling interests in international meat processing operations, mainly in Western Europe, Mexico and China, including a 37% interest in the common stock of CFG, a leading European packaged meats company headquartered in Madrid, Spain, and one of the largest worldwide with annual sales of approximately €2.1 billion (approximately $2.8 billion as of May 3, 2009).
Includes poultry, beef, by-products and rendering
The international segment has sales denominated in foreign currencies and, as a result, is subject to certain currency exchange risk. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Derivative Financial Instruments” for a discussion of our foreign currency hedging activities.
Sources and availability of raw materials
Like the Pork segment, live hogs are the primary raw materials of the International segment with the primary source of hogs being the Hog Production segment. The International segment purchased 76% of its live hog requirements from the Hog Production segment in fiscal 2009. This amount was unusually high due to a decrease in the number of market hogs in Poland. The number of hogs purchased from the Hog Production segment in fiscal 2010 is expected to return to a normalized level of approximately 60%.
Hog Production Segment
As a complement to our Pork and International segments, we have vertically integrated into hog production and are the world’s largest hog producer. The Hog Production segment consists of our hog production operations located in the U.S., Poland and Romania, as well as our interests in hog production operations in Mexico. The Hog Production segment operates numerous hog production facilities with approximately 1.1 million sows producing about 20 million market hogs annually. In addition, through our Mexican joint ventures, we have approximately 90,000 sows producing about 1.7 million market hogs annually.
The profitability of hog production is directly related to the market price of live hogs and the cost of feed grains such as corn and soybean meal. The Hog Production segment generates higher profits when hog prices are high and feed grain prices are low, and lower profits (or losses) when hog prices are low and feed grain prices are high, which was the case in fiscal 2009. We believe that the Hog Production segment furthers our strategic initiative of vertical integration and reduces our exposure to fluctuations in profitability historically experienced by the pork processing industry. In addition, as food safety becomes increasingly important to the consumer, our vertically integrated system provides increased traceability from conception of livestock to consumption of the pork product.
As disclosed above under “Pork Segment,” during fiscal 2008, we acquired PSF, a vertically integrated hog producer and pork processor. PSF’s hog production operations are reported in our Hog Production segment. The acquisition of PSF added hog production facilities in Missouri, North Carolina and Texas with approximately 225,000 sows producing about 4.0 million market hogs annually.